Key takeaways – Market and strategy

The municipal fixed income market, like most other asset classes, is experiencing unprecedented volatility. Large mutual fund outflows are adding to the volatility as investors seek to add to cash reserves by selling what may be deemed easiest to sell. There’s been significant widening in bid/ask spreads as a result of the market sell imbalance and a corresponding significant decline in liquidity.

Right now, the market is trying to determine how to price in the impact of a still-to-be-determined decline in municipal revenues (e.g., sales and income taxes, user fees, toll revenues, etc.). Ten-year municipal/Treasury yield ratios have moved from approximately 80% at year-end to 160%. This could lead opportunistic “crossover/non-tax-sensitive” investors to consider entering the market along with potentially increased demand from tax sensitive-investors.

What’s happened?

  • The municipal fixed income market is currently experiencing a significant dislocation. The bid side is weak due to dealers’ inability to hedge their positions and inventory.
  • Municipal yields have fully reversed the declines that occurred from December 2019 through February 2020 and are now approximately 30 basis points higher across the “AAA” curve.
  • Municipal/Treasury yield ratios have widened significantly and currently exceed 160% of Treasury yields out to 10 years and are slightly lower out to 30 years.
  • The municipal/Treasury yield ratios are inverted (i.e., ratios decrease from 2-year to 30-year maturities); this is a full reversal from where we stood at the end of February 2020.
  • Municipal credit spreads have widened substantially particularly in lower-rated issuers.
  • The new issue market is largely operating on a day-to-day basis; we expect issuers to resume activity as interest develops.

What are you keeping an eye on?

The potential economic disruption that is occurring across the globe is unprecedented. Furthermore, the duration of the disruption is both uncertain and dependent upon the ability of healthcare systems worldwide to arrest the growth trajectory of COVID-19.